The Disney drama that commanded center stage [last] week

trumpeted the themes that will play out this proxy season. Two extraordinary

actions at Walt Disney Co. stand out. First, a startlingly

large 43 percent of voting shareholders withheld support from CEO

Michael Eisner's re-election to the board. Second, in response to the

vote, Eisner stepped down as board chairman but will remain chief

executive. George Mitchell, the presiding director and the former

majority leader of the U.S. Senate, became the non-executive chairman

of the board. Mitchell himself had received a significant 24 percent

withhold vote on his own re-election to the board.

In a statement at the conclusion of the annual shareholder

meeting, the Disney board acknowledged the corporate governance message:

"While there appear to have been a number of different

forces at work in the shareholder vote, a significant message conveyed

in the vote was in the area of governance…

"In particular, there was substantial focus on

the question of whether the Chair and CEO functions at the Company

should be split. That is not to say that we view the vote as limited

to governance issues alone."

Indeed, the Disney drama encapsulates this year's key

issues:

The power of withholding votes from directors

Rising standards for the independence of boards

Separation of the roles of chair and CEO

Executive compensation

Company responsiveness to shareholder resolutions

and majority votes

Shareholder access to the process for nominating

directors

Add auditor independence to the mix, and you have the

traditional ABCs of investor concerns: auditors, boards, and compensation.

These themes are not new. What is new is the intense level of scrutiny

that these issues are receiving — and the startling vote results they

are producing.

Shareholder Access: Waiting In The Wings

Shareholder access to director nominations, still in

the proposal stage, is waiting in the wings. Yet it is already driving

much of the action in indirect but critical ways. The rule proposed

by the SEC would give significant shareholders access to the ballot

for nominating a limited number of directors under certain circumstances,

called triggering events. The SEC has scheduled an all-day roundtable

on the topic March 10, and it is unclear if and when the Commission

will adopt a final rule.

Under the shareholder access proposal, either of two

events would trigger access: withhold votes totaling 35 percent or

more against one or more directors, and majority votes in favor of

shareholder proposals calling for access to the nominations process.

The vote against Eisner easily passed the threshold for the first

trigger. That vote "may put more pressure on the SEC to pass the rule,"The Wall Street Journal reported Thursday.

In crafting its proposed rule, the SEC considered but

decided against a third trigger based on a company's failure to implement

non-binding shareholder proposals that had received majority votes.

Boards argue that, in view of their fiduciary duties, they may have

solid reasons to avoid implementing shareholder proposals.

Nonetheless, boards that ignore majority votes do so

at their own peril. They risk provoking shareholder revolt and triggering

events. Who wants a vote like the one against Eisner?

Which companies stand today as most vulnerable to the

potential triggers? Past vote results are not necessarily indicative

of future ones. Still, it is worth noting that last year 30 percent

or more of voting shareholders withheld votes from at least one director

at these companies:

AOL-Time Warner,

Arden

Realty Inc.

Boise Cascade Corp.

Federated

Department Stores Inc.

Georgia-Pacific

Corp.

Kilroy Realty Corp.

Mesa Air Group

Inc.

Ryder System Inc.

Starwood

Hotels & Resorts.

At least seven firms have failed to enact majority vote

shareholder proposals for four years running: Alaska Air Group,

Baker Hughes, Delphi, Electronic

Data Systems, Federated Department Stores,

Southwest Airlines, and Starwood Hotels &

Resorts.

Company leaders generally insist that they have always

sought to maintain good relations with shareholders. But now they

have additional incentives to reach accommodations with shareholders.

Shareholder activists, meanwhile, are feeling energized to continue

their efforts.

Independent Board Chairman

With critics portraying Eisner as Machiavellian, the

Disney board resisted but eventually succumbed to intense pressure

to split the roles of CEO and chairman. Pointing to what they called

past cronyism on the board, these critics argued that only an independent

chairman would provide proper checks and balances against Eisner,

who has ruled the Magic Kingdom for 20 years. (Former board members

Roy Disney and Stanley Gold go further, arguing that nothing short

of Eisner's removal as both CEO and chairman will do.) But the board,

citing the advice of attorney and corporate governance expert Ira

Millstein, had insisted that such a move was premature and should

await the expiration of Eisner's contract in 2006.

While Disney became a focal point, the issue of independent

chairman extends well beyond the company. Shareholders have filed

more than 30 resolutions calling for an independent chairman. Targeted

companies comprise many in the financial services and oil sectors

and include:

Chevron

Coca-Cola

Colgate-Palmolive

Halliburton

J.P. Morgan

Merrill Lynch

PG&E

Texaco

3M Corp.

(These are initial filings. Many initial filings typically

fail to make it onto the final ballot. In some cases, proponents withdraw

their resolutions after reaching agreement with company. In other

cases, companies win SEC blessing to exclude the proposal from the

ballot.)

Executive Compensation And Golden Parachutes

Executive compensation, long a top corporate governance

concern, also figured prominently in the controversy at Disney. Eisner's

total direct compensation ranks near the 50th percentile for CEO pay

among companies in Disney's peer group. But the national media portrayed

a far different story. On Wednesday, the day of the shareholder meeting,The Washington Post reported that Eisner had been the highest-paid

executive in the country in 1998, taking in more than $550 million

including stock options. Eisner "received sums so large they looked

like typos," The Post opined.

Detractors also have criticized Eisner for awarding

an outsized severance package to Michael Ovitz, who lasted only 14

months as company president. Some estimates put the golden handshake

at up to $250 million.

The California Public Employees Retirement System (CalPERS),

which reportedly owns nearly 10 million Disney shares, has been vocal

in criticizing Eisner. Last summer, CalPERS unveiled tougher voting

guidelines for this year on executive compensation.

This proxy season promises a large number of shareholder

proposals targeted at executive compensation and related issues. Labor

pension funds and other shareholders have filed a slew of proposals,

including:

Expensing Executive Stock Options:

Hewlett-Packard

Intel

Weyerhaeuser

Siebel

Systems

El Paso Corp., among others

Indexing Options to Performance Benchmarks

Sprint

Intel

United Technologies;

Instituting Mandatory

Holding Periods

Bed Bath & Beyond

Autodesk

Tyco has received a "Common Sense Executive

Compensation" proposal from the United Brotherhood of Carpenters

Pension Fund. The proposal calls, among other things, for

ceilings on the CEO's salary (capped at $1 million) and bonus (100

percent of salary).

Other proposals take aim at golden parachutes. At Massey

Energy Co., for example, proponents last year won majority

support for their nonbinding shareholder proposal calling for shareholder

approval of executive severance agreements exceeding 2.99 percent

of base pay plus bonus. This year, proponents have filed a binding

proposal that would force the company to amend its bylaws to achieve

the same effect. Massey has asked the SEC to issue a no-action letter

allowing the company to exclude the proposal from the ballot.

In a sign of the times, a dozen companies have taken

a range of voluntary actions to limit executive severance packages.

These corporations include:

Alcoa

Delta Air

Lines

Hewlett-Packard

Sprint

Tyco

Verizon

Meanwhile, some leading corporations have become new

role models for executive compensation. General Electric

Co., for instance, has given CEO Jeffrey Immelt a compensation package

that emphasizes performance measures with teeth, including five-year

shareholder returns that meet or beat the S&P 500 and 10 percent

annual average cash flow growth for the next five years. Vanguard

founder and ex-CEO John Bogle, a formidable critic of "runaway trends

in executive pay," holds up GE as a model of a shareholder-friendly

approach. IBM and Microsoft also

have won praise from corporate governance advocates for instituting

premium-priced options and restricted stock, respectively.

Anti-Takeover Defenses

Though director independence remained a key concern

of Disney shareholders, observers credited the board with undertaking

governance reforms more recently. Anti-takeover defenses are often

a related concern, because they can be used by management and boards

to entrench themselves. The hostile Comcast Corp.

takeover bid for Disney further highlights the significance of the

market for corporate control — and the noticeable pickup of mergers

and acquisition this year.

Mitchell, in a recent opinion piece in the Wall

Street Journal, highlighted a series of board actions that, he

argued, demonstrated Disney's commitment to governance reforms. In

addition to recent changes, he mentioned two earlier ones: a 1997

decision to de-stagger director elections, and expiration of the company's

shareholder rights plan in 1999.

This year, plenty of other companies are taking steps

to remove or reduce anti-takeover defenses. More than 50 companies

have moved since last year to declassify their boards and allow for

annual elections of all directors. Nearly a dozen of those companies

had seen majority votes — sometimes repeated year after year — in support

of shareholder proposals to declassify the board. At Merck

& Co., for instance, the shareholder proposal had won majority

support for five years. This year, the pharmaceutical company has

agreed to declassify its board. In addition, it recently announced

that it would establish a majority-vote committee to evaluate any

further majority votes at the company.

At Lucent Technologies Inc., a proposal

to declassify the board had been presented to shareholders each year

since 1998 and had received a majority of votes for the past three

years. But at its Feb. 18 meeting this year, Lucent proposed a resolution

to repeal its classified board structure and establish annual elections

of all directors.

The lowering of poison pill defenses also has been striking.

Since last year's annual meetings, some 30 companies have taken actions

to eliminate or amend their poison pills. No fewer than 27 of these

companies previously had received non-binding shareholder resolutions

in the past that had garnered majority support. Moreover, some of

these companies, such as Arden Realty, had witnessed substantial withhold

votes from directors. Just last month,

the following companies took steps to purge their poison pills:

BB&T Corp.

Circuit City

First Energy

Goodyear

Tire & Rubber Co.

PG&E,

Raytheon

Co.

While eliminating or amending their poison pills, a

number of companies are adding a provision that institutional investors

find hard to swallow. The provision enables boards to adopt a poison

pill without shareholder approval if, acting in its fiduciary capacity,

they find the pill in shareholders' interests. Such pills generally

must be put to a shareholder vote the following year. But one year

is too long in the view of critics such as the Council of

Institutional Investors.

Independent Auditors

Auditor independence, while not a prominent issue at

Disney, remains a key shareholder concern at other companies. The

building trade unions have filed more than 90 resolutions calling

for shareholder ratification of auditors and more than 30 proposals

calling for zero tolerance of non-audit fees billed to audit clients.

Shareholder Access

An analysis of the Disney meeting and the proxy season would be incomplete without consideration of the second proposed trigger for shareholder access: proposals from qualified shareholders calling for access to director nominations.

This year, without waiting for the outcome of the SEC rulemaking on its proposal, shareholders have filed proposals asking a handful of companies to allow shareholders to nominate directors. The companies, in turn, have requested SEC approval to omit the proposals from the ballot. Last year, companies succeeded in fending off all such proposals by persuading the SEC to issue no-action letters, which assured that the Commission would take no action against the companies for excluding the proposals.

But in an action that came to light late last week, the SEC staff refused to issue such a no-action letter to Qwest, which was seeking to omit a nonbinding shareholder access proposal filed by two members of the Association of U.S. West Retirees. The SEC statement was dated Feb. 23 and mailed March 1, according to a lawyer involved in the case. The proposal requests that qualified shareholders (owning five percent of the stock for two years) be allowed to propose qualified nominees on next year's ballot.

This is the first time since the shareholder access issue reemerged last year that the SEC has allowed such a proposal, but it may not be the last. The SEC is also considering a no-action request from Putnam's parent company Marsh and McLennan regarding a shareholder access proposal submitted by several institutional investors representing 1 percent of shareholders, including CalPERS and AFSCME.

Also this year, Verizon succeeded in obtaining a no-action letter from the SEC allowing the company to exclude a nonbinding shareholder access proposal from investors. The Verizon shareholder proposal called for investors holding five percent of shares for one year (not two) to be allowed to nominate directors. The resolution at Qwest, unlike the one at Verizon, more closely tracked the SEC rule proposal.

Conclusion

The Disney CEO, board, and shareholders have become

icons: icons of new standards for corporations and boards; of higher

shareholder expectations; and of the newly invigorated power of shareholders.

As the proxy season unfolds, expect continued investor ire, with Disney

perhaps serving as the apex of shareholder revolt. Expect, too, for

at least some corporations to launch governance reforms and move toward

accommodation with their shareholders. Stay tuned.

Stephen Deane is VP and Director of Publications at Institutional Shareholder Services. Patrick McGurn, ISS Senior Vice President and Special Counsel and Rob Kellogg, Director of ISS's Proxy Voting Services, contributed to this article, which first appeared in Institutional Shareholder Service's Friday Report. This column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

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